Subnational fiscal frameworks Scherie Nicol Public Governance & Territorial Development Directorate, OECD 9th Annual Meeting of the OECD Network of Parliamentary Budget Officials and Independent Fiscal Institutions The Scottish Parliament, Edinburgh
A number of factors create adverse incentives for subnational governments to overspend, undertax, and/or borrow excessively – all root causes of fiscal imbalances. A first factor is the “common pool” problem. In an integrated national economic and financial space, the costs of fiscal indiscipline by one or more subnational governments (e.g. an increase in interest rates) are likely to spill over to the others. Moreover, each subnational government will have little incentive to save a windfall in shared revenues, as it may fear that it could lead to future reductions in its share, in favour of higher-spending jurisdictions. A second factor is the moral hazard created by a history of bailouts of subnational governments by the centre. In such cases, the incentives for fiscal responsibility are weakened, as the costs of indiscipline are transferred to the national budget. Moreover, even an explicit central government’s commitment to a no bailout policy may lack credibility, if local governments are responsible for the provision of essential public goods and services, and a disruption in such provision is likely to have strong political and social consequences. A third factor that may adversely affect subnational fiscal discipline is a strong heterogeneity of subnational jurisdictions, not adequately addressed in the design of the system of intergovernmental transfers. If subnational governments differ substantially in their ability to meet centrally mandated standards in the provision of the public goods and services they are responsible for, and transfers from the centre are inadequate to bridge these gaps, pressures to run deficits may mount, especially if the subnational governments have access to bank or other forms of credit (e.g. supplier credit, or indirect borrowing through enterprises they own). https://www.oecd.org/gov/budgeting/43469443.pdf
• Political economy obstacles
– Fragmentation of subnational levels of government
– Differences in the political affiliations
– Fear of encroachment
– Ethnic tensions, differences in natural resources/economic structures/levels of development, or perceived unfairness
• Institutional factors
– Tradition of top down fiscal management
– Spending and revenue functions assigned across government
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Challenges to intergovernmental fiscal cooperation
Presenter
Presentation Notes
Notwithstanding the unwillingness of central government to relinquish control of major revenue sources, and of SNGs to sustain the political costs of taxing their citizens. Fragmentation of sub-national levels of government – Hetreogenity – regarding size, level of economic development, production structure – make it difficult to identify win-win policy options Institutional factors – tradition of top down fiscal management There are economies of scale in tax administration, and SNGs do not always have the capacity to Incentives/fear of encroachment by other jurisdictions or central government
• Current picture: subnational fiscal arrangements
• Recent trends and fiscal challenges
• Strong fiscal frameworks to ensure fiscal sustainability
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Outline of presentation
• Revenue/spending assignment
• Transfer systems
• Fiscal management practices
• Fiscal rules
• Independent fiscal institutions
• Intergovernmental fiscal cooperation
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Elements of a subnational fiscal framework
Presenter
Presentation Notes
Revenue/spending assignment. SNGs need meaningful own-source revenue (for which they can control at least the rate structure). A significant degree of revenue autonomy is necessary to promote subnational fiscal responsibility, avoid soft budget constraints, foster the accountability of SNGs to their electorates, and improve the linkage between taxation with local preferences. The choice, design and reform and revenue/spending assignment has to balance the benefits and costs of each revenue/spending handle, taking into account the relevant economic, institutional and sociopolitical circumstances for each country. Intergovernmental fiscal cooperation can facilitate effective fiscal frameworks. IFC forums in Austria, Belgium and Mexico, among others, have proven to be effective vehicles for exchanging relevant macroeconomic and fiscal information among and within different government levels. For example, Germany has an Intergovernmental Working Party on tax revenue which is responsible for forecasting and distributing revenue shared between the federal government and the states. They can also provide needed venues for central governments and SNGs to present and discuss the repercussions of proposed policy actions at one level of government on the others. Particularly useful where there are high degrees of tax or spending overlap. For instance, France has Contrats de Plan Etat-Regions between the central government and its deconcentrated regions. These agreements have a duration of seven years and aim to ensure that evolving broad national priorities are appropriately reflected in regional investment plans, taking into account regional specificities.
• Strengthen fiscal sustainability
• Ensure effective resource allocation
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Subnational fiscal frameworks aim to:
Good frameworks are the ones that perform against these dimensions
Presenter
Presentation Notes
Unilateral action by various levels of government can have important spillovers on other levels. For example, a central government’s tax and expenditure policies can adversely affect subnational finances. On the other hand, NSGs unsustainable fiscal policies could also have adverse spillover affects on other jurisdictions, and ultimately national finances. Such policies include excessive tax competition leading to erosion of the tax base, inappropriate compensation arrangements which bloat government payroll and inefficiencies in spending and investment. These can lead to the accumulation of substantial deficits and ultimately a subnational debt crisis. However, effective fiscal frameworks can improve both national and subnational macroeconomic management and therefore strengthen fiscal sustainability. In countries where there is a well-established culture of fiscal responsibility and transparency, good fiscal frameworks have an appropriate allocation of tax and spend powers and fiscal targets which are enforced through peer pressure. Effective resource allocation – effective assignment of tax and spending (max autonomy for given input mix) Good frameworks Additional info:
• Diversity of SNGs
• How SNGs are represented in national legislature
• Characteristics of fiscal decentralisation
• Power balances among levels of government
• Form of government
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Factors influencing choice of subnational fiscal framework
• Well designed sub-national fiscal frameworks can strengthen fiscal sustainability and ensure effective resource allocation
– but no easy recipe
– affected by economic, socio-political and institutional factors
Must be tailored to purpose and country circumstances
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Conclusions
Presenter
Presentation Notes
The record of EU Domestic Stability Pacts has been spotty. The limited effectiveness of negotiated fiscal targets is not surprising, since these negotiations are dominated by short-term political objectives. To be effective, fiscal rules need to be: Carefully adapted to the economic, social and institutional context of each country, and adjusted periodically to reflect structural changes in such context. Sufficiently flexible to accommodate unforeseen exogenous shocks and to avoid procyclicality Supported by appropriate monitoring, enforcement and correction mechanisms
Subnational fiscal frameworks and intergovernmental fiscal co-operation
